If President Trump carries through his threat to impose tariffs on all imports into the US, many UK shares will suffer. His promise to “put America first” resonated with the majority of voters. But it could spell trouble for a number of companies on this side of the Atlantic.
However, there’s one stock that I think will do particularly well from Trump 2.0, regardless of whether he introduces import taxes targeted at the UK. That’s because of his wish to make NATO members increase the proportion of their national incomes spent on defence.
Presently, the 32 members have pledged to spend at least 2% of gross domestic product on military hardware and personnel. However, Trump wants them to go further.
On 7 January, he told a press conference: “I think NATO should have 5% … They can all afford it, but they should be at 5%, not 2%.”
Given that the US ‘only’ spends 3.4%, this might sound a bit unfair. However, the point that Trump’s clearly making is that he expects others to spend more so that America can spend less.
This means defence stocks with major US contracts could see a fall in their revenues.
One possible beneficiary
However, a company like Babcock International Group (LSE:BAB) could prosper.
During the year ended 31 March 2024 (FY24), the group earned 70% of its revenue from the UK. It also generated a further 6% from France and Canada, both NATO members.
The group’s exposure to the US is very small and comes primarily from the supply of components to its submarine fleet.
Encouragingly for the group, the UK government has started a Strategic Defence Review and has promised to “set out the path to spending 2.5% of GDP on defence”.
Although this is a long way short of Trump’s 5%, it’s likely to benefit Babcock as governments generally like to keep defence spending local. The group is currently the second largest supplier to the Ministry of Defence.
And now could be a good time for me to invest.
Based on its FY24 earnings, Babcock currently trades on 16.3 times its historical profit. However, this is lower than, for example, BAE Systems (19.5).
If it could attract the same multiple as its larger rival, its market cap would be 19% higher. And with Trump back — and the UK government committed to spending more on defence — I see no reason why this couldn’t happen.
My plan
But I have concerns. The group recently reported £90m of “cost overruns” on the building of five ships for the Royal Navy.
And its dividend is miserly.
Also, I know that investing in the sector isn’t everyone’s cup of tea. But it’s over 4,000 years since the first army was established which, unfortunately, tells me that global conflicts are here to stay. And I believe the first act of government is to protect its people.
That’s why I’ve put Babcock on my watchlist for when I next have some spare cash.
With its impressive 26% return on capital employed (FY24), £9.5bn contract backlog (30 September 2024), and relatively low level of gearing, I think Babcock’s well placed to benefit from Trump’s second term and the UK government’s commitment to spend more on defence.
The post As Trump enters the White House, this UK share looks at least 19% undervalued to me! appeared first on The Motley Fool UK.
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James Beard has no position in any of the shares mentioned. The Motley Fool UK has recommended BAE Systems. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
